CAH - Cardinal Health: Better EPS Growth Clarity Buying Back Shares A Buy On Valuation

2023-08-07 05:34:18 ET

Summary

• Health Care Services stocks have underperformed in the US market, but Cardinal Health has bucked the trend.
• CAH is one of the largest drug and medical product distributors, with strong earnings growth and a positive outlook. The firm is also buying back its shares with ample FCF.
• The stock is undervalued, with a compelling valuation and a powerful uptrend, making it a buy ahead of earnings on the 15th.
• I outline key price levels to watch on this strong-momentum name.

Health Care Services stocks have been an underperforming area of the US market over the past two years. The area continues to struggle with how elective procedures in a post-COVID world will look. While the S&P Health Care Services ETF ( XHS ) has produced negative alpha compared to the S&P 500 in the last two years, one company has bucked the industry trend.

I have a buy rating on shares of Cardinal Health ( CAH ) as I see the stock still undervalued as earnings growth runs strong despite the robust rally over the past several quarters.

Cardinal Health a Winner Within A Struggling Industry

According to Bank of America Global Research, CAH is one of the largest drug and medical product distributors. The company generates approximately two-thirds of its profit from the pharmaceutical business and nearly one-third from its medical business. The pharmaceutical distribution business supports retail/mail/hospital/physician clients as well as drug manufacturers. The medical business manufactures its own portfolio of medical products and distributes brand-name products to hospitals and physicians.

The $23 billion market cap Ohio-based Health Care Distributors industry company within the Health Care sector trades at a high 52.4 trailing 12-month GAAP price-to-earnings ratio and pays a 2.2% dividend yield. Ahead of earnings next week, shares have a tame implied volatility percentage of 25% as of August 4, 2023. The at-the-money straddle implies a 4% earnings-related stock price swing while short interest is low at 2.8%, so we shouldn't see major volatility next week.

CAH endured a tough end to last week with the stock plunging 2.7% for its worst day since March. Still, shares are down just a few percentage points from the all-time high notched at the end of this June. A low-volume, low-volatility pullback has taken place in Q3 so far, and the most recent important news event took place two months ago.

Cardinal's Investor Day was met with buying among investors. The management team offered insights into growth plans for its Pharma and Medical segments - it now projects EPS growth in the +12% to +14% range through 2026, helping to give investors visibility into the forward profitability picture.

What I particularly liked about the event was that the company now expects to repurchase at least $2 billion of stock over the next three years. Combine double-digit EPS growth with a dwindling share count, and investors should stand to benefit. That positive event came after a solid earnings beat back on May 4. The firm posted operating EPS of $1.74, easily above the $1.49 consensus forecast while revenue verified at $50.5 billion, up 2% from the same period a year ago and $870 higher than expectations.

Cardinal raised its free cash flow forecast to the $2.0 to $2.3 billion range. These are all great signs, in my opinion. The firm is clicking on many cylinders, though risks include worsening drug pricing pressure, heightened competition (perhaps from Amazon), supply chain disruptions, and any lingering demand challenges post-COVID. Its Medical segment has also been somewhat underperforming its Pharma unit, so that space is a potential sore spot.

On valuation , analysts at BofA see earnings rising at a fast pace over the coming quarters. That robust growth outlook has been evidenced by CAH's impressive performance over the past two years. Operating per-share earnings are expected to hurdle $6 on a trailing 12-month basis over the coming quarters.

The Bloomberg consensus forecast is slightly less sanguine compared with BofA's outlook. Dividends, meanwhile, are expected to hover just above $2.05 on an annual basis, but with ample free cash flow growth and strong profitability trends, I would not be surprised to see further shareholder accretive activities through FY 2025.

Cardinal Health: Earnings, Valuation, Free Cash Flow Forecasts

If we assume $6 of non-GAAP earnings per share over the coming four quarters, then the stock trades at a 15 price-to-earnings multiple. That is not all that expensive considering that the industry median P/E is north of 20. But it is key to compare CAH to itself, and the stock is at about a 50% premium to its 5-year historical operating earnings multiple.

If we assume a 15 P/E and long-term earnings growth of 11%, then the PEG is merely 1.4, attractive both on an absolute and relative basis. I assert that a sector P/E is fair, which would put the stock near $120. Thus, I have a buy on valuation.

CAH: Compelling Valuation Metrics Considering Double-Digit EPS Growth

Compared to its peers , CAH has much better Quant Rankings per Seeking Alpha, particularly on the valuation front. Couple that with strong momentum , and this quality name has a lot going for it, and investors get an above-market 2.2% dividend yield along the way. I would like to see improved operating and EBIT margins, though. Nevertheless, earnings revisions have been to the good side over the recent months.

Peer Comparison

Looking ahead, corporate event data provided by Wall Street Horizon show a confirmed Q4 2023 earnings date of Tuesday, August 15 BMO with a conference call immediately after the numbers hit the tape. You can listen live here . There are no other volatility catalysts seen in the coming months.

Corporate Event Risk Calendar

The Technical Take

With the stock about 25% undervalued in my view, the chart situation is likewise positive. Notice in the graph below that CAH has been in a steady but impressive upward trend since Q2 2022. After holding key support in the mid-$40s through 2021, its bull market took flight right as the broader market headed south. While I certainly recognize that the stock has already doubled and that I am probably a bit late to the party, I see further room for Cardinal to fly.

The current pattern annotated by the orange lines in the chart below is a bull flag. CAH is nearing its rising 50-day moving average for the first time since early June, and we could ultimately see a retest of its 200-day moving average which is also upwardly sloped. I see support in the $80.50 to $82 range, so buying today and then adding to the position if we get a pullback could be a wise play around earnings next week. A sell stop under the $73 mark is also prudent as that would likely indicate that the uptrend that started more than a year ago has ended. A key risk on the chart, though, is that volume trends are not all that great - a lower amount of shares traded has been the trend since late last year. I would like to see volume come into the stock as it ascends.

Overall, the trend is clearly up, and most indicators support the bullish narrative.

CAH: Powerful Uptrend Persist, Buy the Dips

The Bottom Line

I have a buy rating on Cardinal Health. This fast-growing Health Care sector company has solid free cash flow, a decent yield, an attractive valuation, and an appealing chart ahead of the Q4 report on the 15th.

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